Communications Sector Rating: Underperform

Communications sector overview

Concerns over peak growth rates and potential regulations appear to be weighing on the group. Costs also seem likely to go up as the fight for consumers escalates.

Market outlook for the communications sector

We continue to hold an underperform rating on the group and don’t think the recent modestly better performance should be chased by investors. The communications sector certainly includes some of the most exciting and cutting-edge companies, and there is hardly an American that isn’t in contact with multiple companies within the group on a daily basis. But that also leads to intense competition for those consumers’ attention. To us, this raises the potential that some of the current leaders in the sector may be reaching the saturation point, which could result in at least a temporary slowdown in the growth rate of a good-sized portion of the group. As a result, we continue to rate the communications sector at underperform.

New methods of communication, new content, and new ways to consume content are all likely interesting to most investors. They certainly are interesting to advertisers, who are constantly looking for new ways to target their potential consumers. And even more exciting may be the potential rollout of the next generation of wireless technology—so-called 5G. This rollout has the potential to affect the rest of the sector, as it would allow movies to be downloaded in seconds instead of minutes, while the number of devices able to be supported within a square kilometer is estimated to move from about 2,000 with 4G to about 1 million with 5G (The Wall Street Journal).

But one concern we have is that all of this excitement costs money. Pursuing new technologies and providing quality content has costs associated with it, and we believe that those costs are likely to grow over the coming year. Also, with some of the companies in the group growing into some of the largest-cap stocks in the U.S., they are attracting more attention from the government, which has expressed concern about both the size of some of these companies as well as their protection of the privacy of their consumers. Part of the reason advertisers were so willing to spend an estimated $107 billion on online advertising in 2018 (eMarketer) is the ability of those online sources to better target those ads to specific consumers. If their ability to collect consumer data were to be curtailed, their ability to grow revenues could be more limited.

While the communications sector has many exciting companies, we currently believe the stocks of many of those companies have risks that outweigh the potential rewards … at least for now. That’s why we continue to hold an underperform rating on the group.

Factors that may affect the communications sector

Positive factors for the communications sector include:

Increasing wireless demand: Demand is rising as more communication and media devices move to the wireless arena, providing the potential for revenues to rise. Meanwhile, the projected rollout of 5G technology could enhance that demand to an even greater degree.

Solid advertising demand: With good content and better ability to target consumers, advertisers may be more willing to increase their spending with some of these companies.

Negative factors for the communications sector include:

Slowing revenue growth: With so many people already using many of the primary services in the group, future growth rates may start to slow.

Rising expenses: Expenditures in the communications space seem likely to increase as more content is needed and faster network speeds are pursued. This could be a burden on profitability.

Regulatory risk: With the size and collection of personal data by some of the biggest companies in the group attracting the attention of the government, new restrictions are a threat that could affect revenue growth.

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